Although having knowledge that taxes are dischargeable in bankruptcy, many attorneys still perceive that the tax collector elbows everyone aside and gets paid. Personal income taxes are dischargeable. Practitioners should know the basic requirements and the nature of the individual tax liability that may be discharged in a Chapter 7 bankruptcy.
WHAT TAXES ARE DISCHARGEABLE
The Bankruptcy Code does not specify taxes that are dischargeable. It specifies taxes that are excepted from discharge. Income taxes excepted from discharge are primarily addressed in Bankruptcy Code sections 507(a)(7)(A), 523(a)(1)(B) and 523 (a)(1)(C). In simple language, unless secured, income taxes are not excepted from discharge, and consequently are dischargeable if:
- A return has been filed;
- If filed, assessment was not based on fraud;
- If filed late, the return was filed two years or more before the bankruptcy petition;
- The tax return, with extensions, was due three years or more before filing of the bankruptcy petition; and
- Tax liability was assessed more than 240 days before filing of the petition.
None of the above may fail.
SECURED TAX CLAIMS
A filed federal tax lien encumbers exempt property. Internal Revenue Code section 6321. A tax claim is secured to the extent that IRS holds money (such as a tax refund) which can be set off against the tax claim, and to the extent that property is available to satisfy a recorded notice of federal tax lien. Consequently, even if the tax liability is otherwise dischargeable, a federal tax lien survives to the extent that there is exempt, abandoned or other pre-petition property available to secure the tax debt.
Therefore, a practitioner should know whether a notice of federal lien has been properly filed before advising clients with respect to discharge. If a lien has attached, to the extent of available property, IRS is a secured creditor, and negotiations with IRS will be required.
To advise a client with respect to dischargeability of income taxes, an attorney must determine the following:
- Due date of a tax return, including extensions;
- Date of filing return, if filed;
- Date of assessment of tax liability; and
- Whether a notice of lien has been filed, resulting in a secured claim.
With that information, one can determine if and to what extent individual income tax liability is discharged in bankruptcy.
DETERMINING APPROPRIATE INFORMATION
- Due Date of Return. The due date of a return is generally common knowledge. Whether extensions were received must be determined from your client's records.
- Filing Date. The date a return was filed should be part of your client's records. Failing records, after some delay, filing date can be determined from State and Federal records.
- Date of Assessment. "Assessment" is the recording of liability in the office of the Secretary of Treasury pursuant to Treasury Regulations. The date of the assessment is the date the summary record is signed by an assessment officer. The Secretary of Treasury is authorized to "assess" taxes. Internal Revenue Code section 6201(a). Income taxes are automatically "assessed" for the amount shown on a tax return, for taxes due as a result of mathematical error on a filed tax return, and for taxes due pursuant to agreement. However, in all other instances, assessment can be made only 90 days after the Secretary has sent a Notice of Deficiency to the taxpayer's last known address, and then if not stayed by Tax Court or other proceeding. Unless the date of assessment is known, a taxpayer or his attorney may and should request a copy of the Record of Assessment from the IRS before filing a bankruptcy petition. Filing less than 240 days after assessment will result in a non-discharge.
- Notice of Lien. The Notice of Lien is a document filed with the records of the local county clerk. To become a lien upon real property such notice must be filed in the county where real property is located.
If the liability is dischargeable, notice of bankruptcy must be given to the Internal Revenue Service. Failure to give proper notice to the IRS will result in non-discharge of liability. In an adversary proceeding, or to challenge an IRS claim, notice must also be given to the U.S. Attorney and to the Justice Department, Tax Division, Washington, D.C.
In the Laguna Niguel District, the proper address for notice is:
Internal Revenue Service
Special Procedures Function
P.O. Box C-13
Laguna Niguel, CA 92677
Notice to Fresno or notice made to less than all required agencies may also result in non-discharge.